Stock build-up squeezes cotton

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The global economic slowdown has reduced demand for cotton and boosted inventories

Cotton prices have been falling since May. The fall in the last six weeks is the longest in 55 years.

Cotton No. 2 futures traded on the ICE, which is the benchmark for global cotton traders, are down 34 per cent from 94.89 cents per pound in May. In the domestic market, cotton futures traded on the MCX are down 18 per cent over the same period.

The global economic slowdown has reduced demand for cotton, resulting in a sharp increase in inventories. According to data from the US Department of Agriculture (USDA), global cotton inventories touched 1 billion bales (of 227 kg) in 2013-14 (August-July), up 11.7 per cent from 90 million bales in 2012-13. The USDA projects inventories to increase by another 5 per cent in 2014-15 to 1.05 billion bales.

High inventories will continue to keep cotton prices lower for some more time.

Imbalance

The market for cotton has been in surplus for many years now. Though the quantum of surplus has narrowed in the past few years, it is not helping prices go up. That’s because the drawdown in surplus is not happening because of an increase in demand. Rather, it is due to the relatively larger fall in production. The USDA forecasts global cotton consumption to increase 2.7 per cent in 2014-15 to 1.1 billion bales. Production is likely to fall 1.6 per cent.

The increase in consumption may not, however, impact cotton prices in the near term due to huge inventories.

India is the second-largest producer and consumer of cotton. According to the third advance estimates from the Ministry of Agriculture, the country’s cotton production is expected to be 365 lakh bales (of 170 kg each) in 2013-14 (October-September), up 6.7 per cent from 342.2 lakh bales in the 2012-13 crop season.

The increase in production would add to the already high inventory of cotton in the country. So there is all probability of cotton prices moving further down in the coming months.

Technical Outlook

Medium-term view: The MCX cotton (₹17,650 per bale) futures contract is in a strong downtrend. The contract recorded a high of ₹21,450 per bale in May and has tumbled 18 per cent from there. It has been moving in a bear channel since then. Strong resistance is at ₹19,300.

Currently, the probability is very low for the contract to breach this level.

Last week, the contract breached its psychological support at ₹18,000. This has opened the doors for MCX-cotton to test ₹17,000 and ₹16,800 now.

Traders with a medium-term perspective can go short on this contract. Stop-loss can be kept at ₹18,200 for the target of ₹16,800.

Intermediate rallies to ₹18,000 can be considered for accumulating more short positions with the same stop-loss.

The first positive signal would come out only if the contract breaks above ₹18,000 now and the outlook will turn entirely bullish only if the contract breaches ₹19,300 decisively. Such a break can take the contract higher to ₹20,300.

On the global front as well, the outlook is bearish for the Cotton No. 2 (62.49 cents per pound) futures contract, the global benchmark traded on the ICE.

There has been a prolonged triangle formation since mid-2012, a bearish breakout of which has happened in July.

Resistance is at 80 cents per pound. While the contract remains below this level, there is a danger of a fall to 45 cents in the coming months.

Short-term view: The MCX cotton futures contract reversed higher initially last week but failed to breach its 21-day moving average at ₹18,872. Some support for the contract is at ₹17,200.

While above this level, an intermediate bounce to ₹18,000, which is a key short-term resistance level, looks possible. An immediate break of this resistance looks less probable.

A reversal from ₹18,000 will keep the overall downtrend intact and drag it lower to ₹17,200 and ₹17,000 in the short-term.

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